NEW YORK, Dec 22 (Reuters) - A Y2K-inspired surge in demand for liquid assets has prompted the Federal Reserve to add more than twice the reserves to the banking system for this year-end than it did last year, economists said on Wednesday.

While some worry the central bank's accommodation of surging money demand will overstimulate the economy and drive up inflation, the Fed kept interest rates steady on Tuesday and made clear it will provide whatever liquidity is necessary for the transition to the year 2000.

Economists who closely track the Fed say the dramatic acceleration in some measures of money and credit growth in the past few months is a distortion, driven by fear of year-end financial market disruptions from the Y2K computer software glitch.

``They are certainly providing a significant amount of liquidity. It is obviously temporary,'' said Marc Wanshel, a Fed watcher at J.P. Morgan Inc. ``But it's not going to fuel faster growth in the economy or multiply into huge increases in the financial money supply.''

If the inflated demand for reserves does not taper off after the New Year, though, it could give the Fed one more reason to raise borrowing costs. The Fed hinted on Tuesday another rate rise will be on the table in February.

The Fed has already put in place around $90 billion of reserves that will be available to markets on Dec. 31, and that number is expected to surpass $100 billion with money market operations in coming days. About $38 billion was available on Dec. 31, 1998.

Some $80 billion of the $90 billion is temporary additions by repurchase agreements to finance securities dealers which include banks and brokerages.

In addition to the repos, the permanent reserves the Fed has added this quarter total about $10 billion, but that figure was around $8 billion for the same period last year.

Repos allow dealers to sell U.S. government or agency securities to the Fed and buy them back at a certain date. The outstanding repos expire between Jan. 5 and Feb. 9, so that liquidity will naturally flow out of the system at that time.

That is one reason many economists dismiss the notion the Fed is engineering a dangerous expansion of money that may be driving up an already richly valued stock market and adding to inflationary pressure in the economy.

``All signs are this is a Y2K phenomenon that is going to resolve itself and the Fed can get back to fundamental concerns,'' said Dana Saporta, economist at Stone & McCarthy Research Associates.

The strains on banks and dealers come from an increased demand for cash from a number of sources, as a precaution against any Y2K disruptions.

Banks are holding more cash in vaults to meet any unusual customer demand. Individuals may be holding more currency, and mutual funds may be increasing cash positions in anticipation of rising redemptions.

Although the surge in liquidity demand was expected, Saporta said she was surprised by the magnitude. Still, she said it was hard to argue that money growth was driving the stock market up.

``It is clear that the bulk of the extra liquidity is pooling up in bank vaults right now, awaiting withdrawals from individuals. I don't see any connection between that and a few tech stocks that are skyrocketing,'' Saporta said.

Fearing that financial markets could seize up at year-end if market makers see too much Y2K risk, the Fed has implemented a series of extraordinary measures to meet liquidity needs.

It extended the terms of repos from a maximum of 60 days to 90 and expanded the array of accepted collateral.

The Fed also sold dealers an insurance policy -- nearly $500 billion in options. The first options can be exercised on Thursday and the others can be exercised on Dec. 30 and Jan. 6.

But the options will only add to liquidity if exercised, which is seen as highly unlikely barring a spike in the Fed's 5.5 percent target federal funds rate for overnight lending among banks.

To keep the fed funds rate on target, the Fed has had to satisfy the increased demand for reserves by adding much more than normal. Continued strong demand for money or credit after the Y2K phenomenon could be a sign that borrowing costs are too low.

Two friends of mine at work just bought large blocks of stock that
they cannot really afford. They are taking out home equity loans and
drawing their bank accounts way below what prudence would require.
They don't want to lose out on what they think is the greatest stock
surge in history. I am afraid that they will be very sorry come
January. Greedspin and Co. are driving the masses wild with greed
and envy.

Nick Guarino of the Wall Street Underground is extremely p*ssed off
that Greenspan has flooded the economy with extreme liquidity. Nick
has predicted that next month, when the Fed demands its repos be
repaid, the stock market will WIPE OUT!

There was a very interesting article in Monday or Tuesday's NY Post
about this situation. Kinda alarming when their financial reporter
basically announces he finally GI's and by the way he's taking two
weeks off and is gonna "Sweep out his Y2K bomb shelter".